Determining Fair Broker Charges
Question: In a recent column, you said that, under the Real Estate Settlement Procedures Act, yield spread premiums retained by brokers are legal if they are “reasonably related” to the value of the services provided to the borrower. How does the Department of Housing and Urban Development enforce this rule?
Answer: It doesn’t. My searches have revealed only a single enforcement action by HUD related to excessive broker charges, and it was directed against the lender funding the loans rather than the brokers.
Yield spread premiums are payments made by lenders for loans with high interest rates. YSPs are often retained by mortgage brokers as part or all of their compensation. At issue is whether YSPs retained by brokers are “reasonable compensation” for services to the borrower, or illegal referral fees that provide no benefit to the borrower.
HUD formulated the reasonable compensation rule but has never enforced it--probably because it can’t figure out any way to do it. There is no effective way to enforce the rule by examining broker compensation and the services performed in individual transactions.
Gathering the required data from brokers is far beyond HUD’s capacity. It has never had more than four examiners enforcing all RESPA rules, of which the broker compensation rule is just one. Mortgage brokers will be involved in about 3 million transactions this year.
Furthermore, there are no generally accepted standards as to what constitutes “reasonable” compensation. Is, say, $4,500 on a transaction excessive? A HUD examiner has no way of determining how many hours the broker spent educating the client, or how much money the broker may have saved the client through astute loan selection and shopping. In addition, any fair assessment should take into account small loans made by the same broker on which the fee might be only $500. These quandaries would defeat the wisest examiners.
But there is a way to enforce the reasonable compensation rule that is within HUD’s capacity, and that uses a simple standard of reasonableness that commands wide agreement. The standard is what an informed client is willing to pay.
Consider the market for legal services where fees vary widely. Does the lawyer who bills at $450 an hour earn excessive compensation relative to one who gets $90? For most people, if the client knows the price is $450 and willingly agrees to pay it, then it is not excessive.
This principle of informed client consent could be applied to mortgage broker compensation. HUD could define reasonable compensation as any compensation that borrowers willingly agree to in advance.
The problem created by YSPs is that borrowers don’t necessarily consent to paying them. They frequently do not understand that they are paying the YSP in the interest rate. Furthermore, the exact amount of the YSP is not known until the terms of the loan are locked with the lender, at which point the borrower is already committed to the transaction.
HUD could remedy this by declaring brokers to be in compliance with the reasonable compensation rule if they require all customers paying YSPs to acknowledge the broker’s total compensation, in writing, before the broker has submitted an application to a lender. Total compensation is the amount paid the broker by the borrower and the lender. The borrower would have to pay the difference between the total and the YSP.
Suppose, for example, the borrower agrees to total compensation of $4,500, and the broker estimates the YSP at $3,000, leaving a direct borrower-paid fee of $1,500. If the YSP turns out to be $4,000 when the terms are locked instead of $3,000, the direct fee is cut to $500.
HUD should provide brokers with a standard form. The Web version of this column will show the form I developed in collaboration with Upfront Mortgage Brokers, who voluntarily follow the compensation rule proposed above.
The beauty of this approach to broker compensation is that HUD’s rule will be enforced by lenders. The recent court decision declaring YSPs to be illegal referral fees exposes lenders offering YSPs to legal liability. But lenders will be safe in offering YSPs to brokers who comply with HUD’s reasonable compensation rule. Lenders will thus have an incentive to monitor broker compliance, and stop offering YSPs to those who flout the rule.
For purposes of this rule, HUD should define “mortgage broker” to include loan providers who fund loans but have price commitments from wholesale lenders. They receive the equivalent of YSPs from their lenders, and should be subject to the same rules. Otherwise, brokers who don’t want to comply with HUD’s rule will begin funding loans, or become employees of firms that do.
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Jack Guttentag is a syndicated columnist and professor of finance emeritus at the Wharton School of the University of Pennsylvania. Questions or comments can be left at https://www.mtgprofessor.com. Distributed by Inman News Features.
